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Your investment freedom-maker

Given that repeated research has found that a diversified portfolio's asset allocation is responsible for the vast majority of its variations in returns over time, it makes much sense for investors to get it right.

And once investors set an appropriate strategic asset allocation – the targeted exposure to different investment asset classes – they should gain more freedom to concentrate on the other fundamentals of sound investment management.

In a way, the creation and implementation of a portfolio's strategic asset allocation – perhaps using low-cost, indexing-tracking exchange traded funds (ETFs) or their equivalent in unlisted traditional index funds – could be described as a freedom-maker.

With their asset allocation in place – reflecting an investor's goals, tolerance to risk and expectations for returns – they can focus more on such critical issues for investing success as:

Personal financial management: This includes such seemingly everyday matters as budgeting, keeping your debts under control (including your mortgage and credit card) and simply managing your personal cash flow. The efficient management of your personal finances may hopefully free up more money to invest.

Smarter investor behaviour: Disciplined investors adhering to a strategic asset allocation should be less inclined to chase past performance (switching to investments that outperformed in the recent past), get caught up with the investment herd (who tend to buy when prices are high and sell low), and try to pick tomorrow's investment winners. The list goes on. It's worth setting aside time to think about how to become a more disciplined investor who avoids emotionally-driven investment decisions, taking a long-term perspective.

Portfolio rebalancing: This disciplined strategy involves periodically rebalancing a portfolio back to its strategic asset allocation. Rebalancing should recapture a portfolio's intended risk-and-return characteristics. It is a smart way to periodically respond to movements in markets without being distracted by market “noise” as share prices move up and down.

Cost control: High investment costs, including management fees, handicap real returns. And the negative impact of high fees compounds over time. Investors don't only forgo the money paid in high fees but the returns that this money may have earned over the long term.

Tax efficiency: Investors can help keep their returns as high as possible in a low-interest environment without taking extra risks by ensuring that their investment taxes are efficiently managed. Be a tax-sensitive investor. Ways to improve tax efficiency can include investing more in concessionally-taxed super and low-turnover ETFs tracking broad sharemarket indices.

Retirement drawdowns: Retirees face the task of efficiently drawing down on their retirement savings each year to strike a balance between having a satisfactory lifestyle and making their money last as long as possible. (See A dynamic approach to retiree spending and drawdowns, Smart Investing, September 11.)

Estate planning: Your estate planning should aim to ensure that your wealth efficiently passes to beneficiaries in the way that you intend while minimising the possibility of family disputes. Regarding your super, consider whether to nominate preferred beneficiaries or make binding death benefit nominations. Surveys for the 2018 Vanguard/Investment Trends SMSF Report, published earlier this year, confirms that estate planning is among the highest unmet needs for advice among self-managed super funds.

In short, having an appropriate strategic asset allocation in place gives you more freedom to concentrate on other matters under your control, rather than worrying about what's beyond your control. Of course, setting the right asset allocation is at the top of what's under your control.

Written by Robin Bowerman Head of Corporate Affairs at Vanguard. 02 October 2018 vanguardinvestments.com.au